Monday, March 26, 2012

In its recent decision in Am. Auto. Ins. Co. v. Sec. Income Planners & Co., 2012 U.S. Dist. LEXIS 39444 (E.D.N.Y. Mar. 22, 2012), the United States District Court for the Eastern District of New York had occasion to consider exclusions in a professional liability applicable to commingling and/or conversion of client funds, and whether these exclusions applied to the named insured’s negligent failure to prevent an employee from committing such conduct.

American Auto Insurance Company (“AAIC”) insured Security Income Planners & Co., LLC (“SIPCOLLC”), and others, under a life insurance agents errors and omissions policy.SIPCOLLC and its president and CFO, Jay Hoffman, were named as defendants in an underlying suit alleging that Mr. Hoffman concerning his fraudulent conduct as an insurance broker.Mr. Hoffman had, in fact, previously pled guilty to twenty-four (24) counts of criminal activity committed in his capacity as a broker during the period 1989 through 2009.Among other things, Mr. Hoffman testified that he had “engaged in a scheme constituting a systematic ongoing course of conduct with the intent to defraud ten or more people by false or fraudulent pretenses, representations or promises, and obtained property from one or more such persons.”Among these defrauded persons were plaintiffs in the underlying action, who alleged causes of action against SIPCOLLC and Hoffman for unjust enrichment, misrepresentation and failure to pay amounts owed.Plaintiffs later amended their complaint to allege causes of action against SIPCOLLC for negligence, negligent training and supervision and breach of fiduciary duty.

AAIC argued that it had no duty to defend or indemnify its insureds in light of a policy exclusion stating

We shall not be liable to make any payment for Loss in connection with any Claim:

K. Based upon, arising out of . . . 3. Any commingling, misappropriation or conversion of funds.

AAIC also relied on a policy exclusion stating:

We shall not be liable to make any payment for Loss in connection with any Claim:

B. Based upon or arising out of any Insured gaining in fact any personal profit or advantage to which such Insured was not legally entitled.

Citing to Bistricer v. Fed. Ins. Co., 2003 U.S. Dist. LEXIS 17227 (S.D.N.Y. Sept. 30, 2003), a case in which the Southern District of New York held that an improper profit exclusion in a directors and officers policy did not apply to a negligent supervision claim, SIPCOLLC, and plaintiffs in the underlying action, argued that the exclusions in the AAIC policy did not apply to the negligence supervision claim.The court agreed, citing to numerous cases cited under New York law, under a variety of policies including professional and general liability policies, holding that a negligent supervision claim against the named insured triggers at least a duty to defend even if the conduct alleged against an individual insured falls within a policy exclusion.As the court explained, “because New York courts hold that negligence or negligent supervision claims arising from fraudulent or intentional acts are not excluded by insurance policies similar to the policy at issue, the negligent supervision allegation set forth in Gross and Cerulli's amended complaint suggests a ‘reasonable possibility’ of coverage” and thus a duty to defend was triggered.

Friday, March 23, 2012

In its recent decision in Farkas v. Nat'l Union Fire Ins. Co., 2012 U.S. Dist. LEXIS 38696 (E.D. Va. Mar 21, 2012), the United States District Court for the Eastern District of Virginia had occasion to consider the application of exclusions in a directors and officers policy barring coverage for wrongful gains and fraudulent conduct if proven “in fact.”

An individual insured – the chairman and majority shareholder of the insured entity – was indicted for multiple counts of committing and conspiring to commit bank, wire, and securities fraud.He sought coverage under the D&O policy issued by National Union.National Union agreed to advance defense costs in the criminal proceeding, subject to a reservation of rights on the following policy exclusions:

The Insurer shall not be liable to make any payment for Loss in connection with a Claim made against an insured: [4(a)] arising out of, based upon or attributable to the gaining in fact of any profit or advantage to which an Insured was not legally entitled; [and] . . . [4(c)] arising out of, based upon or attributable to the committing in fact of any criminal, fraudulent or dishonest act, or any willful violation of any statute, rule or law.

A criminal trial resulted in the insured being convicted of sixteen counts of fraud and conspiracy to commit fraud.National Union subsequently disclaimed coverage on the two policy exclusions, contending that the conviction proved “in fact” that the insured had gained a profit to which he was not legally entitled and that he had committed fraudulent or dishonest acts.In the subsequent coverage action, National Union sought a declaration that not only did the exclusions apply, but that it was entitled to recoup defense costs already advanced.

The insured argued that the exclusions were ambiguous as to when they apply, and were thus unenforceable.The court rejected this argument, noting that the majority of courts to have considered similar “in fact” exclusions have ruled that “some pertinent factual finding” is all that is necessary to trigger these types of exclusions, and that the underlying criminal conviction, resulting from a jury trial, satisfied this requirement.Moreover, the court rejected the insured’s argument that the potential for a reversal on appeal precluded a finding in National Union’s favor, noting that there was no case law to support such an interpretation of the “in fact” language.The court also noted that “in fact” language, as opposed to similar exclusions only requiring a “final adjudication,” gives the insurer insurer the option to obtain a finding “in fact” in a declaratory judgment action or to rely on the outcome of the underlying action.

The court further found that in light of the finding that the policy exclusions applied, National Union was entitled to recoup defense costs already paid, since the policy contained a provision stating that “advanced payments by the Insurer shall be repaid to the Insurer by the Insureds or the Company, severally according to their respective interests, in the event and to the extent that the Insureds or the Company shall not be entitled under the terms and conditions of this policy to payment of such Loss.”

Friday, March 16, 2012

One of the more perplexing issues faced by insurers is how to handle multiple claims, or a claim involving multiple insureds, when there are insufficient policy limits available to pay all loss.In states where insurers are not free to settle claims on a first-come, first-serve basis, interpleading the policy limits into court may be an option.In its recent decision in Everest Indemnity Ins. Co. v. Aventine-Tramonti Homeowners Association, 2012 U.S. Dist. LEXIS 33860 (D.Nev. Mar. 13, 2012), the United States District Court for the District of Nevada, in a matter of first impression under Nevada law, addressed the protections afforded by interpleader.

The insurer, Everest, issued a primary owner-controlled insurance program (OCIP) in connection with the construction of a housing development.The policy had a $1 million limit of liability that was eroded by defense costs or, as the court described it, a “burning limits” policy.Two of Everest’s insured were sued in connection with a construction defects suit, and Everest undertook their defense.Everest paid nearly $150,000 in defense costs before offering the remaining limit to the claimant.This offer was rejected, and the claimant indicated that it would continue to pursue a multi-million dollar judgment and that the complaint would be amended to add several other defendants qualifying as insureds under the policy. Recognizing that there would be numerous insureds competing for the same remaining $850,000 limit, Everest terminated its defense and filed an interpleader action, whereupon it sued approximately sixty (60) of the insureds under its policy for an interpleader and declaratory relief.The underlying matter eventually settled and the court released the interpled funds to the underlying plaintiff and defendants.

At issue in Everest was the breach of contract and bad faith claims raised by one of the insureds under the policy, Rising Sun, which while not a defendant at the time Everest terminated its defense of the underlying suit, was later added as a defendant.At that time, Rising Sun tendered its defense to Everest.Everest denied a defense to Rising Sun and instead directed it to request from the court periodic disbursements from the interpled funds to pay for its defense.Rising Sun argued that Everest had a duty to defend each of its insureds until the policy limit was exhausted and that paying the funds into the court as part of an interpleader action did not constitute exhaustion.

The court held that under the circumstances, Everest’s commencement of an interpleader was the appropriate mechanism for resolving the various parties’ claims to the limited fund and that by doing so, Everest properly discharged its duties under the policy.Upon commencing the interpleader and paying the funds into the court, a party such as Rising Sun was required to seek reimbursement for defense and indemnity payments from the court rather than from Everest.Depositing the funds in this manner, observed the court, is a “sure way for an insurer to extinguish its duties.”While the court acknowledged a lack of Nevada law on the issue, the court reasoned that “interpleader would seem to extinguish the duty to defense, because the potential for indemnification ceases when the policy limits are interpled, after which the insured can no longer reach any assets of the insurer under the policy, but only the interpled funds.”

Wednesday, March 14, 2012

Scottsdale Indem. Co. v. Village of Crestwood, 2012 U.S. App. LEXIS 5069 (7th Cir. Mar. 12, 2012), the United States Court of Appeals for the Seventh Circuit, applying Illinois law, had occasion to consider the nature and purpose of the total pollution exclusion.

The underlying facts in Village of Crestwood involved traditional environmental pollution, and as such, did not appear to be the type of case that would require an extensive judicial opinion.A number of residents of the Village, a small suburb of Chicago, alleged in individual tort suits that the in the mid-1980s, the Village became aware of PCE or “perc” contamination of one of its municipal drinking wells, but nevertheless allowed the wells to be used for drinking water through 2007.In addition to these tort claims, the State of Illinois brought suit against the Village, seeking to require the Village to delineate and remediate any environmental contamination.The Village’s general liability insurer, Scottsdale, denied coverage for the suits on the basis of its policies’ pollution exclusions, and the United States District Court for the Northern District of Illinois ruled in Scottsdale’s favor on motion for summary judgment.

On appeal to the Seventh Circuit, Judge Posner agreed that perc qualified as a contaminant, and that there was a requisite discharge, dispersal, release, etc., of the perc such that the pollution exclusion applied.Judge Posner added, however, that “the problem with stopping there and affirming the district court in one sentence is that a literal reading of the pollution exclusion would exclude coverage for acts remote from the ordinary understanding of pollution harms and unrelated to the concerns that gave rise to the exclusion.”Instead of giving a one-sentence affirmance, Judge Posner followed with a multi-page disquisition on the history and purpose of the exclusion.

Judge Posner began his analysis by observing that the pollution exclusion should not apply each time an injury has a nexus to a contaminant.For instance, when a car spins out in an oil slick and results in injury to the driver, it cannot be said that the driver suffered bodily injury because of a pollutant.It is for this reason, explained Judge Posner, that Illinois courts have limited application of the exclusion to traditional environmental pollution, most notably in American States Ins. Co. v. Koloms, 687 N.E.2d 72 (Ill. 1997).Judge Posner agreed with this rationale, but nevertheless observed that:

A more perspicuous formula than "traditional environmental pollution" would be "pollution harms as ordinarily understood." That formula would also exclude the case of the leaking furnace; for think of what a misuse of language it would be to say that the workers had been injured by pollution. If one commits suicide by breathing in exhaust fumes, is that death by pollution?

Judge Posner followed this query by engaging in an analysis into the purpose of the exclusion.The exclusion did not come into prominence out of a “fear by insurance executives of losses by insureds.”Rather, the need for the exclusion arose out of general liability carriers’ inability to predict and calculate losses that can result from pollution.The inability to properly assess risk, he explained, results in arbitrary premiums and the potential for overinsurance.This, in turn, raises the potential for “adverse selection,” which could have negative societal consequences:

Overinsurance would attract people who valued their property at less than its insured value, and the addition of such people to the insurance pool would increase the probability of losses and so drive up premiums. Legitimate insurance purchasers would respond to the increased premiums by shifting their business to companies that refused to overinsure, and this would raise the probability of losses to the (shrunken) insurance pool of the first company and drive its premiums even higher. It would be a death spiral. The fear of such spirals explains the exclusion of pre-existing medical conditions from health insurance policies, the requirement in the federal health-reform law that in exchange for the elimination of that exclusion everyone be required to have health insurance, and laws requiring all motorists to have liability insurance as otherwise premiums would be driven to high levels by the most careless drivers, causing the safer ones to drop insurance, although that is not the only reason for such laws.

In other words, Judge Posner sees societal need and value in allowing insurers to have exclusions for risks that cannot be adequately valued.This is particular true for environmental contamination, which “is often very difficult to detect until it has become extensive, let alone to predict, or estimate its likely extent, in advance; and the financial consequences can be horrific but again are unpredictable.”This, he explained, created the adverse selection risk:

The main reason for the broad pollution exclusion is the adverse-selection problem of which we gave examples earlier. It is true that there is adverse selection only where the adverse factor, such as a pre-existing medical condition or the very low value placed by a property owner on his property, is invisible to the insurer, who therefore can't adjust the insurance premium to the greater risk of loss from insuring those people—can't in other words separate its high-risk customers from its low-risk ones and charge different premiums to the different groups. But invisibility is a problem with pollution insurance too, as this case illustrates dramatically: deliberate concealment by the insureds of the pollution is alleged. If insurers can't determine how likely a would-be buyer of insurance is to pollute, coverage would force enterprises that have a slight risk of liability for causing pollution damage to subsidize the premiums of high-risk potential polluters.

Insurers could have excluded coverage just for knowing or deliberate polluting, which would have done the trick in this case but would not be a complete solution to the adverse-selection problem. A shopper for pollution insurance who knows that he has a high risk of accidentally polluting and being sued for it would, if able to buy the insurance at the normal premium, contribute to the premium spiral that we've described. Forcing him to self-identify as a potential polluter by buying a pollution-coverage rider to his general liability policy (as otherwise he will fall within the pollution exclusion) separates high- and low-risk polluters.

Judge Posner thus concluded that the pollution exclusion serves an important purpose in keeping insurance premiums in check, but that the exclusion must be narrowly restricted to harms that can reasonably understood to result from pollution.

In reaching this conclusion, Judge Posner considered but rejected the Village’s argument that application of the exclusion should be limited to instances where the insured actually caused the contamination.The language of the exclusion did not support such a narrow reading, and in any event, the Village bore responsibility for concealing the contamination from its residents for nearly a quarter of a century.Judge Posner further observed that identifying the cause of the contamination was a pointless exercise in reductive reasoning:

The Village "caused" the contamination of its water supply (it could have sealed the well a quarter of a century ago, when it discovered the well was contaminated) in a perfectly good sense of the word, though [it] did not introduce the contaminant into the soil or groundwater. The contamination had an infinity of authors, not only the Village and its officials but also the inventor of perc, the founder of Crestwood, and maybe Jean Baptiste Point du Sable, who built a farm at the mouth of the Chicago River in the 1780s and is thought to be the first permanent non-native settler of the Chicago area. None of the other authors could be thought to have caused the contamination and resulting injury in a sense of "cause" that is relevant to legal liability.

Thus, he concluded, limiting application of the exclusion to the actor responsible for the contamination would render it “largely nugatory” and frustrate its purpose.Judge Posner also rejected the Village’s argument that the exclusion should not apply to an insured involved in the distribution of a product (water) that could be contaminated, i.e., a “core business activity” application.This distinction, he noted, does not resolve the adverse-selection problem, since an insurer can no more easily predict the risk of contaminated products than it can predict the risk of environmental pollution.

The insureds claimed that their vacation home in Lake Tomahawk, Wisconsin was rendered uninhabitable, and unsaleable as a result of a significant accumulation of bat guano between the home’s siding and walls. Among other things, the insureds alleged that the guano created a “penetrating and offensive odor” for which they had been informed there was no guarantee of complete remediation. The insureds sought coverage under the homeowner’s policy issued by Auto-Owners, and alleged that the odor rendered the house a total loss. In fact, the insureds eventually had their house razed as a result of the alleged odors.

Auto-Owners disclaimed coverage on several grounds, including its policy’s pollution exclusion, which barred coverage for a “discharge, release, escape, seepage, migration or dispersal of pollutants.” The term “pollutants” was defined by the policy as:

The trial court ruled in favor of Auto-Owners on summary judgment, concluding that guano falls within the definition of “pollutant” and that there was a seepage or dispersal of the guano that resulted in a loss to the insureds. The court of appeals reversed, concluding that an insured would not reasonably interpret bat guano to fall within the definition of pollutants, and that the exclusion, when read as a whole, did not suggest “a biological process such as the movement of excrement.”

On further appeal, however, the Supreme Court of Wisconsin held that the exclusion applied. In reaching its holding, the court was required to determine whether guano constituted a “pollutant,” and if so, whether there was a requisite discharge, release, escape, etc. In considering the first issue, the Court looked to its prior decisions in Donaldson v. Urban Land Interests, 211 564 N.W.2d 728 (Wis. 1997), where it held that carbon monoxide buildup as a result of inadequate building ventilation did not qualify as a “pollutant,” and Peace v. Northwestern National Ins. Co., 596 N.W.2d 429 (Wis. 1999), where the Court held that lead paint chips qualified as a pollutant. From these cases, the Court stated a general rule that matter generally understood to be harmful is a “pollutant.” With this in mind, the Court concluded:

Bat guano, composed of bat feces and urine, is or threatens to be a solid, liquid, gaseous irritant or contaminant. That is, bat guano and its attendant odor “make impure or unclean” the surrounding ground and air space, and can cause “inflammation, soreness, or irritability” of a person’s lungs and skin.

The Court further reasoned that guano “unambiguously” constitutes an irritant, or a contaminant, or waste. With regard to the latter, the court concluded that a reasonable insured would ordinarily expect that the term “waste” includes bat feces and urine, notwithstanding the definition’s reference to “materials to be recycled, reconditioned or reclaimed.”

The Court further held that there was a requisite discharge, release, escape, etc. of the guano as required by the pollution exclusion. The Court noted that each of the terms used in the exclusion connote movement and “are often synonymous with one another and ‘taken together constitute a comprehensive description of the processes by which pollutants may cause injury to persons or property.’” The Court specifically found that the odor emanating from the guano evidenced the movement and the resulting harm necessary for the exclusion to apply:

The bat guano, deposited and once contained between the home’s siding and walls, emitted a foul odor that spread throughout the inside of the home, infesting it to the point of destruction … Accordingly, implicit in [the homeowners’] complaint is an allegation that the bat guano somehow separated from its once contained location between the home’s siding and walls and entered the air, only to be absorbed by the furnishings inside the home. According to the Hirschhorns, the result was the total loss of their vacation home. Such an allegation falls squarely within the terms of the pollution exclusion clause.

Tuesday, March 6, 2012

In its recent decision in Secura Ins. v. Horizon Plumbing, 2012 U.S. App. LEXIS 4477 (8th Cir. Mar. 5, 2012), the United States Court of Appeals for the Eighth Circuit, applying Missouri law, considered whether an underlying breach of contract claim could be construed as an “occurrence” triggering coverage under a general liability policy.

The claims at issue in Secura arose out of the construction of an apartment complex in Kansas City, Missouri.The owner, Metropolitan, hired Weitz Company as the project’s general contractor, and Weitz, in turn, hired Horizon Plumbing as the plumbing subcontractor.The project ran into financial troubles and delays, which ultimately resulted in Metropolitan terminating Weitz.Weitz later sued Metropolitan for breach of contract. Metropolitan asserted a counterclaim against Weitz, alleging that Weitz committed numerous breaches of contract, including failure to timely complete the project, failure to provide progress reports, failure to supervise and pay subcontractors in a timely fashion, failure to maintain adequate accounting records, and failure to correct deficient and defective work.Weitz and Metropolitan both asserted third-party claims against Horizon for defective plumbing.Among other things, they alleged that Horizon failed to properly connect various balcony drains, which allowed for water intrusion and mold.Horizon’s insurers defended and ultimately settled these third-party claims.

At issue in Secura was whether Weitz, as an additional insured under Horizon’s policies, was entitled to coverage with respect to Metropolitan’s counterclaim.Metropolitan was awarded $5 million in connection with its counterclaim, and the court ordered Horizon to pay Weitz $115,619.80 in attorneys’ fees and $12,576.30 in costs, these amounts be described as the portion of Weitz’s defense of the counterclaim arising out of Horizon’s allegedly defective plumbing work.Horizon’s insurers paid this amount.Weitz claimed subsequently claimed that as an additional insured under Horizon’s policy, it was entitled to reimbursement of the entirety of its costs in defending Metropolitan’s counterclaim – an amount approximating an additional $1.1 million.Horizon’s insurers took the position that no coverage obligation was owed with respect to the remainder of the counterclaim because it did not allege “property damage” resulting from an “occurrence.”

Weitz argued that Metropolitan’s breach of contract counterclaim triggered coverage because it sought damages for, among other things, Horizon’s defective plumbing.The court disagreed, finding that each of Weitz’s alleged failures “was within [its] control and management and its failure to perform cannot be described as an undesigned or unexpected event” and thus did not constitute an “occurrence.”Moreover, the court rejected Weitz’s argument that the claim for failure to repair constituted an occurrence, explaining that:

Contrary to Weitz's contention, the disclosure of damages sought for failure to remediate defective workmanship was not based on an "occurrence" but rather a breach of a specific contractual duty to correct deficient work. There was no allegation of an accident or that Weitz's conduct had caused property damage. The fact that Weitz's failure to correct the defective workmanship resulted in financial expenses to Metropolitan was a "normal, expected consequence of [Weitz's] breach of contract and not an occurrence."

In passing, the court noted that while an additional insured is entitled to a defense, an insurer’s coverage obligation to an additional insured is limited to damages arising out of the named insured’s work.Horizon’s insurers, explained the court, should not be required to provide a full defense merely because Metropolitan’s counterclaim included a small component related to Horizon’s work.As the court concluded, “the insurers have already paid Weitz for all defense costs related to Horizon's work and they owe nothing more.”

Thursday, March 1, 2012

In its recent decision in Hartford Cas. Ins. Co. v. Construction Builders In Motion, Inc., 2012 U.S. Dist. LEXIS 25240 (E.D. Ill. Feb. 28, 2012), the United States District Court for the Northern District of Illinois, applying Illinois law, considered whether a declaratory judgment action should be dismissed on the basis of the Wilton/Brillhart abstention doctrine.

The Construction Builders case involved coverage litigation arising out of allegedly defective construction of a single home in Chicago.In the underlying action, the homeowner sued the general contractor, Kaiser, which in turn asserted third-party claims against several subcontractors, including Construction Builders. Hartford, as the insurer of Construction Builders, brought suit in the Northern District of Illinois, seeking a declaration that it had no duty to defend its own insured or Kaiser.Hartford also named as defendants a number of other insurers under which Kaiser qualified as an insured or as an additional insured.Hartford sought a declaration that if it did owe a defense obligation to Kaiser, then this obligation should be shared equally with each of the other insurers.

Among the insurers sued by Hartford were Rockford Mutual and Pekin Insurance, both of which were insurers of Kaiser’s subcontractors.Kaiser claimed to be an additional insured under the policies issued by these insurers.Rockford Mutual and Pekin had each brought separate lawsuits in Illinois state court seeking declarations that they owed no coverage obligations with respect to their own insureds or to Kaiser.Rockford Mutual and Pekin Insurance, therefore, moved to dismiss Hartford’s lawsuit on the basis of the Wilton/Brillhart abstention doctrine, arguing that the court should abstain from hearing Hartford’s claims in light of their already filed state court actions.

The Construction Builders court acknowledged that as a general proposition, abstention pursuant to this doctrine is appropriate “in a diversity case where a declaratory judgment action is sought and a parallel state court proceeding also exists.”Matters are considered “parallel” when “there is a substantial likelihood that the state court litigation will dispose of all claims presented in the federal case.”With these principles in mind, the Construction Builders court rejected the argument that Hartford’s federal court action was parallel to the lawsuits pending in state court, explaining:

While this case includes some of the parties and issues that will be decided in the state court actions, at best the state cases will resolve the coverage dispute as to one or two of the insurers, leaving this case to decide remaining issues of contribution or allocation, as well as any of the coverage as to the insurers who have not brought a state declaratory action.In short, this case is not parallel to the state court case and this litigation, not a web of state court cases, will be the best way to sort out the coverage obligations and, if necessary, apportion defense costs and damages.

In reaching its holding, the court rejected the argument that Rockford Mutual and Pekin would be forced to incur extra costs by litigating in multiple suits.The court stated that Rockford Mutual and Pekin were free to dismiss their own state court litigations and prosecute their claims in Hartford’s lawsuit.The court further reasoned that because the issues bearing on the duty to defend were relatively straightforward and required little discovery, there would be only minimal extra costs imposed on the insurers by having to litigate in multiple suits should they opt not to discontinue their state court claims.